Why Should You Be Freaked Out About Greece? Remember, The Great Depression Had Two Parts

The most terrifying words I've seen written so far about the growing crisis in Greece were penned by Yves Smith yesterday: "So the whole idea that the financial crisis was over is being called into doubt. Recall that the Great Depression nadir was the sovereign debt default phase. And the EU's erratic responses (obvious hesitancy followed by finesses rather than decisive responses) is going to prove even more detrimental as the Club Med crisis grinds on."

The Great Depression was composed of two separate panics. As you can see from contemporary accounts--and I highly recommend that anyone who is interested in the Great Depression read the archives of that blog along with Benjamin Roth's diary of the Great Depression--in 1930 people thought they'd seen the worst of things.

Unfortunately, the economic conditions created by the first panic were now eating away at the foundations of financial institutions and governments, notably the failure of Creditanstalt in Austria. The Austrian government, mired in its own problems, couldn't forestall bankruptcy; though the bank was ultimately bought by a Norwegian bank, the contagion had already spread. To Germany. Which was one of the reasons that the Nazis came to power. It's also, ultimately, one of the reasons that we had our second banking crisis, which pushed America to the bottom of the Great Depression, and brought FDR to power here.

Not that I think we're going to get another Third Reich out of this, or even another Great Depression. But it means we should be wary of the infamous "double dip" that a lot of economists have been expecting. The United States is in comparatively good shape, but the euro is in crisis, and already-weak European banks seem to be massively exposed to Greece's huge debt load. They're even more exposed to the debt of the other PIIGS, which is far too large for it all to be bailed out. The size of the rescue package that Greece needs is already going to take a fairly substantial chunk of the IMF's war chest.

And yet, like a lot of analysts, I don't see much chance that a bailout is going to work. As Felix Salmon points out, even a substantial IMF intervention isn't going to bring yields down to their pre-crisis levels, because the new debt is going to jump in front of other creditors--so while it reduces the odds of default, it also increases the haircut that debtors will have to take if the bailout actually happens.

It's not clear that Greece has the political will for the austerity measures it's going to have to make even if its debt yields come back down--and the higher they stay, the smaller the chance. This is about the calculation its creditors are making, which is why yields are now in the 20% range. Which, perversely, makes it more likely that they're going to lose their money.